Rising interest rates: not all pension plans are impacted the same way

Rising interest rates: not all pension plans are impacted the same way

Interest rates affect everyone, from everyday affordability of food, fuel and shelter to the long-term viability of their retirement goals. That’s why being aloof to interest rates or blissfully unaware of their impact is a luxury you can’t afford, even if they seem intimidating or difficult to understand.

In this article, we’ll focus less on the nuts and bolts of the rates themselves (that kind of information is best received from a trusted financial professional) and more on how their fluctuations affect pensions—a key component of a financially healthy retirement for those who have them.

If you've been following the recent rise in interest rates, you may be wondering what it means for your pension benefit. The answer depends largely on the type of pension plan you have.

For participants in traditional pension plans, higher interest rates often result in lower lump sum values. That's because lump sums are calculated by converting future monthly pension payments into a present-day value. When interest rates increase, that present value decreases, leading to smaller lump sum payouts. 

Cash balance plans, however, can tell a very different story.

Many cash balance plans provide annual interest credits based on a fixed rate or an index tied to government securities, such as the 1-Year or 10-Year Treasury. As Treasury yields rise, these plans may credit more interest to participant accounts, helping balances grow faster over time. 

Higher rates can also benefit participants who elect an annuity from a cash balance plan. Depending on the plan's conversion assumptions, the same account balance may produce a higher monthly payment in today's environment than it would have when rates were lower. 

As you can see, higher interest rates can be a headwind for some and a tailwind for others. Knowing your plan's design is key to understanding how today's interest rate environment could affect your retirement benefit and help you end up in the win column with your pension.

So what does this mean for you?

Don't assume that rising interest rates will impact your pension the same way they affect someone else's. The most important step you can take is to understand how your plan works.

Review your Summary Plan Description (SPD) and any retirement resources available through your benefits website so you know whether changes in interest rates could affect your lump sum value, account growth, or monthly pension payment. A few minutes spent understanding your pension today can help you make more informed retirement decisions tomorrow.